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When you pay your mortgage, the interest and principal repayments aren’t the only things on the bill. There typically are taxes and insurance too. One of those extra expenses is called PMI, or private mortgage insurance.
Private mortgage insurance is usually required when you have a down payment of less than 20% of your home’s purchase price. This extra fee is paid by you, even though the lender is the one benefiting from the insurance.
Your credit score, down payment, and how much coverage your loan requires, based on Fannie Mae or Freddie Mac guidelines, all influence your PMI costs, says David Dye, licensed mortgage broker and owner of California-based Goldview Realty.
If you can avoid paying PMI, you can save hundreds of dollars a month.
When Will You Need to Pay for Private Mortgage Insurance?
For most conventional loans, in order to avoid paying PMI your loan-to-value ratio (LTV) must be 80% or less. You can calculate LTV by dividing the loan amount by the home’s value, and it is expressed as a percentage. For example, if you take out an $80,000 mortgage on a $100,000 home your LTV is 80% ($80,000 mortgage/$100,000 property value).
Government-secured mortgages are entirely different.
If you have bad credit, a government-secured loan may have cheaper mortgage insurance, because your credit score won’t affect the fee.
Each type of government-insured home loan has slightly different rules regarding PMI. Insurance on these mortgages is not called PMI, but is simply known as mortgage insurance or a mortgage insurance premium (MIP). The two main types of government-backed loans that have a MIP are Federal Housing Administration (FHA) and U.S. Department of Agriculture Rural Development (USDA) mortgages.
For both of these mortgage types, you’ll almost always be required to pay mortgage insurance for the life of the loan. The size of your down payment won’t affect whether or not you pay a MIP. The one exception is if you have a down payment of at least 10% on an FHA loan; in that case, you can have the mortgage insurance waived after 11 years.
How Much Does Mortgage Insurance Cost?
Looking for the cheapest mortgage insurance shouldn’t be the driving factor in choosing a mortgage, however. The rate and lender fees will have a much bigger impact on what mortgage is the best deal for you.
That said, it’s all about risk: the stronger your financial profile, the less you’ll pay. If you can scrape together a good-sized down payment, and have a high credit score with a low debt-to-income ratio, your PMI will be less expensive.
PMI usually costs between 0.5% and 2% of your mortgage balance each year. The average mortgage amount in the U.S. is over $200,000, so PMI can cost up to $4,000 per year for an average homeowner.
If a low credit score will make your PMI fee unreasonably expensive, then you should run the numbers for an FHA loan, because the MIP on it isn’t affected by your credit score. An FHA loan’s annual mortgage insurance fee is .45%-1.05% of the loan balance, and is based on the loan amount, loan to value, and the length of the loan.
FHA loans require an extra upfront mortgage insurance fee of 1.75% of the loan amount, in addition to an annual mortgage insurance premium. But even with that fee, you may be able to save in the long term if your monthly mortgage insurance payment is significantly cheaper. Just keep in mind that it’s more difficult to remove the mortgage insurance requirement from an FHA loan than it is with a conventional loan.
How to Remove PMI
How you get rid of your mortgage insurance requirement depends on the type of loan you have, so it’s important to understand the rules in advance.
Removing PMI usually requires an increase in the property’s value or equity and/or paying the mortgage for a certain number of years, says Walda Yon, chief housing programs officer at the Latino Economic Development Center. For example, in some situations you may be required to have been paying the mortgage for two or five years before PMI can be dropped; this is known as a seasoning period. You also have to be current with your mortgage payments and have a good payment history to be able to remove PMI.
Request PMI Cancellation at 80% LTV
If you weren’t able to put down 20% when you purchased the property, you can have PMI waived once you’ve built up enough equity over time.
But your lender isn’t going to automatically cancel your PMI premium once you’ve reached 80% LTV. You’ll have to reach out and request it. Your lender may require some form of appraisal to verify the property hasn’t lost value, but that’s not always the case.
To drop your PMI requirement, you may also be able to prove that the home has increased in value through appreciation or property improvements. In this case, you shouldn’t just go and get an appraisal without communicating with your lender first, because when you waive PMI with a reappraisal a seasoning period is likely to apply. Call the loan servicer first and ask about getting the PMI removed, and they’ll tell you what their process is, Dye says.
In most cases, the borrower will be responsible for the cost of the appraisal, which can easily be around $500. Dye recommends borrowers run the numbers to make sure they are actually saving.
Wait for PMI to be Automatically Cancelled at 78% LTV
Under the Homeowners Protection Act, your lender must automatically cancel PMI on the date your LTV will be at 78% based on the original payment schedule. If you make extra payments and your LTV hits 78% earlier than scheduled, you’ll have to reach out to the lender in order to have PMI removed earlier.
Refinance Your Loan
Depending on your situation, refinancing your mortgage may be the only option for getting rid of PMI. This is usually the case for FHA and USDA mortgages.
Refinancing isn’t free, so you need to consider closing costs, which are typically 2%-6% of the loan balance. Paying thousands of dollars out of pocket to remove a small monthly PMI fee might not make sense. You could roll the refinancing costs into your new loan, but then you’ll need to have enough equity to be able to absorb the closing costs and still be at 80% LTV or less on the new mortgage.
Refinancing a conventional mortgage could also make sense because it allows you to get around the seasoning period. If you’ve made significant improvements to your home or live in a quickly appreciating area, you may have built up enough equity to waive PMI before you’ve had the loan long enough to meet the seasoning requirements. In this case, you can refinance to have PMI waived regardless of how long you had the original mortgage. But again, you need to consider whether or not the PMI savings outweigh the refinancing costs.
Other Ways to Remove Private Mortgage Insurance (With Caveats)
Purchasing a home with a big down payment or building up equity are often the best ways to avoid PMI, but they aren’t the only ones. There are other, but more complicated, ways to get the job done. These tactics won’t make sense for everyone, but it’s good to understand how they work so you don’t end up making an uninformed decision all in the name of avoiding PMI.
If you come across a mortgage advertised as having no PMI even if you put down less than 20%, pay attention to the mortgage rate. A lot of lenders will offer no PMI with only 5% or 10% down, but it’s a marketing gimmick, Dye says. The cost of PMI is built into a higher interest rate.
With a higher rate over the life of the loan, you could end up paying more. PMI can eventually be waived, whereas you’re stuck with a higher rate. Even a small interest rate increase can be extremely costly, especially on longer term loans. For example, a quarter of a percentage point interest rate increase could increase what you owe on a $200,000 30-year loan by $10,000 over the full term.
So if you’re considering a no-PMI loan, compare the interest rate to other loans to make sure you’re actually saving money.
Piggybacking a Second Loan
You may be able to only put 5% or 10% down on a home purchase and take out a second loan to avoid PMI. The lender is generally only concerned about the LTV on the first mortgage loan, says Thomas Bayles, senior vice president at the Los Angeles-based Mortgage Capital Partners. Bayles has worked with homebuyers who avoided PMI with a 10% down payment by financing the other 10% with a home equity line of credit.
If this is a strategy you’re considering, you’ll need to do your homework and make sure the math works out. Second mortgages have higher rates than traditional home loans, and a HELOC’s rate is usually adjustable, meaning it can increase after an introductory period. A HELOC will typically have a shorter repayment schedule than a traditional mortgage, and may have a large balloon payment at the end or prepayment fees. So you always need to understand how a HELOC will affect your monthly payments down the road.
If you think piggybacking loans to get rid of PMI is good for you, make sure you understand all the ins and outs of a second loan. Otherwise, stick with one of the more traditional methods of avoiding PMI.
Mortgages backed by the U.S. Department of Veterans Affairs never need mortgage insurance. However, if you qualify for a VA loan, you need to factor the upfront funding fee, which can top 3%, into your decision. Depending on how expensive the funding fee is, it could still be cheaper than paying PMI, but it might not be as good of a deal as it first seems. Some veterans may qualify for a funding fee waiver. Be sure to talk with your lender or local VA representative, because in that case, VA loans are an even better option.